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Demand Estimation

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DEMAND ESTIMATION

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DEMAND ESTIMATION 1. Elasticities of the independent variables

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Demand equation is given by: QD = -5,200 – 42P + 20C+ 5.2(I) + 0.2(A) + 0.25(M) 100cents = 1$ P = 500 cents, C = 600cents, I = 550,000cents and A = 1,000,000, M = 5,000 QD = -5,200 – [42 × 500] + [20 × 600] + [5.2 × 550,000] + [0.2 × 1,000,000] + [0.25 × 5,000] QD = -5,200 – 21,000 + 12,000 + 2,860,000 + 200,000 + 1,250 QD = 3,047,050 a) Price elasticity of demand (PED) Price elasticity of demand is computed using the following formula:
������������ ������������

× ������ where ������������

������

������������

represents the change in quantity demanded with respect to a unit change in price (indicated by the coefficient of P in the equation) PED = -42 ×
500 3,047,050

= - 0.00689 The price elasticity of demand implies that any 1% change in the price of the product causes a 0.00689% change in quantity demanded. A further implication is that a change in price leads to a less than proportionate change in quantity demanded hence making the demand for the product is price elastic. Any increase in price will lead to a decrease in quantity demanded of the product, this is indicated by the negative sign of the price elasticity of demand. The firm should increase its price since this will result into an increase in its total revenue as the consumers will still be willing to consume more than the quantity demanded.

DEMAND ESTIMATION In this case, a reduction in price will lead to a more than proportionate increase in quantity demanded but the firms profit margins will reduce as the market share increases. b) Cross-price elasticity of demand (CED) This is the change in quantity demanded due to a change in the price of other related good. It is calculated by: ������������������ ×

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